How Does Proration in Real Estate Work at Closing?
March 6th, 2023
Nobody said that real estate transactions are simple. From negotiating with agents and banks to gathering all the required documents to figuring out who pays closing costs, it takes a lot of work. And then there’s proration. So what’s proration in real estate?
In this article, we will explain what proration is and how it works when you are buying or selling a house. We’ll also cover some of the most common prorated costs and how they are calculated. So let’s start.
What Is Proration?
Proration in real estate is the process of dividing transferable property-related expenses (e.g. property taxes) between the buyer and seller, typically at closing. In other words, proration means calculating and diving who pays for what once a property is sold in such a way that both parties pay only for the time they owned the property.
Let’s say you just sold a house. You pay property taxes for that house, typically in two yearly installments. But there’s no reason for you to pay property taxes after the property is no longer yours, right?
However, you can’t just pay a portion of the taxes according to your calculations and call it a day or give the new owner how much you think the taxes will be. Well, ultimately, that is the point – for you to pay your dues (in this example property taxes) only for the duration that you own the house.
It’s just that, like most other things relating to real estate, there is a lot of bureaucracy and procedures on how it must be done. And that’s what proration is – the official process of dividing the expenses so that each party only pays for the time they own the property.
Paying in Advance and Paying in Arrears
Here, we should note that you can pay expenses in advance or in arrears (paying later for costs that have already been incurred). To use the example of property taxes again – you may pay them in arrears, i.e. in 2023 you will pay the property taxes for 2022. These two types of payment methods are important because they will influence how proration is calculated.
Types of Prorations
Proration can be done with most expenses that should be divided between the buyer and the seller, but the most common types of prorations that relate to real estate are:
Property Tax Proration
The way you pay property taxes varies by state and sometimes by county. You may pay them in advance or in arrears, based on where your property is located. Depending on the situation:
- If the taxes are paid in advance, the buyer will need to reimburse the seller for the number of days of property taxes the seller paid in advance but did not own the home. The difference will show up as credits for the seller on the closing statement and debit for the buyer.
To give an example, if you sold your house on June 1st but paid your yearly property taxes in advance, the buyer will need to credit you for the amount you paid from June 2nd to December 31st.
- In the opposite situation, when the taxes haven’t been paid yet, the reverse is true. The seller will need to credit the buyer for the unpaid property taxes up until the date that the property was sold.
So property tax proration is the process of making sure that both the buyer and seller pay taxes for the time they owned the property. We should also mention that prorated charges can be deducted from your federal tax just like regular property taxes.
HOE Fees Proration
If your property is in an HOE area, you likely have to pay HOE fees. Just like property taxes, you only need to pay the fees for the time you owned the house. HOA fees are typically paid from the proceeds of the sale and the seller gets credited by the buyer for the extra days that they paid.
Rent Prorations
Assuming you own a rental property and that your renters pay in advance, you are only entitled to the part of the rent that was due for the days that you owned the property. So, if the rent is $1,500 per month and you sold the property on the 15th, both you and the buyer get an equal share.
The buyer would receive prorated credits of $750 on the closing statement, while you, as the seller, would have prorated dues of $750. Security deposits from the renters (if a deposit was given) are also transferred in full to the buyer as credit.
The Role of the Escrow Agent in the Proration Process
Proration in real estate is the process of properly dividing real estate-related costs between the buyer and the seller at closing. While these costs are relatively minor compared to other closing costs, they can still be tricky to calculate and transfer properly.
Were property taxes paid in advance or are they yet due? How much are the prorated property taxes? What were the HOE fees? How about rent? That’s why escrow exists. Your escrow agent will calculate what expenses were paid in advance and what in arrears. The agent will calculate who gets what and make sure it shows up on the closing statement.
And prorated property taxes, HOE fees, and rent are the simpler parts of a real estate transaction. There are many more moving parts, like agent fees, transferring deeds, calculating mortgages, etc. that can stall or even make a real estate deal fall through.
But that’s where we can help. Lightspeed Escrow was founded by real estate experts with the aim of making real estate transactions as painless and quick as possible. We offer fast and accurate escrow services that can help selling or buying a house go smoothly.
If you need professional escrow services or even just need advice from our escrow agents, don’t hesitate to contact us.